A foolproof financial plan is a requisite for a financially secure future. Irrespective of your life stage and monetary responsibilities, having a financial plan is a much needed asset that you must have in your arsenal. Whether you are saving for your retirement, paying a mortgage for your home, or funding your educational expenses, all aspects require intricate financial planning. However, despite understanding the necessity of a sound financial plan, most people do not undertake relevant measures to create a financially safe future. Nearly three in four Americans are troubled about their financial future, as reported by a recent survey. People are concerned about paying off their loans, sponsoring their child’s education, saving for their retirement, fulfilling emergency health expenses, and more. Financial worries have become a reality, especially in the current COVID-19 times. The survey reports that 68% of the survey participants are anxious about not having adequate retirement savings, 56% are worried about the steeply rising inflation, and 45% are concerned about paying off their loans and managing their debt.
As you step into the New Year, look back at your financial performance of the past year and assess your mistakes. If you do not have a financial plan, it is advisable to create one for the following year. However, if you were following a financial plan, evaluate your success against your goals. If you have successfully achieved your goals for 2021, your financial plan might only require some updates and is fit for your 2022 objectives. Alternatively, if your financial plan was unsuccessful in helping you achieve your 2021 objectives, you should consider reviewing your strategy and identifying areas of improvement for a successful run in 2022. To make 2022 a financial success, aim to cover any loopholes and frame an effective strategy that fits your aspirations for the next year. Drafting a sound financial plan is one way to stay ahead of the crowd and make intelligent life decisions regarding different aspects, such as budgeting, investment, retirement planning, tax management, debt management, estate plans, etc. At the most basic, your financial plan can use your current variables to plan for the future and assure you that your money will not outlive you.
Financial planning is fundamental to your long-term economic well-being, especially when events like the current COVID-19 pandemic wrinkle your financial abilities to earn, save, and invest. A recent study pointed out that 9 in every 10 Americans are financially stressed because of the COVID-19 pandemic. Hence, as you step into the New Year, it is beneficial to create a 100% failsafe financial plan and stay on the right track, avoiding critical financial mistakes. To do so, you can reach out to a professional financial advisor who can guide you and assess your financial goals and objectives for 2022 to ensure you are on the right track.
As you shape your long-term financial plan, here are some of the top financial mistakes to avoid:
- A failure to plan financially for your future:
- Setting unrealistic expectations while financial planning:
- Lack of an adequate emergency corpus:
- Not having a workable budget in your financial plan:
- Not saving enough for yourself first:
- Overspending over your planned financial budget:
- Making unwise investments that are not suitable for your financial goals:
- Forgetting to optimize taxes:
- Forgetting to update insurance plans:
- Missing out on estate planning:
One of the most common money management mistakes people make is delaying their financial plan and failing to take action in this regard. Procrastination is a common personal financial planning mistake. Most people wait until they turn 30 to begin their retirement planning, which is critically late given the rising life expectancy, low bond yields, and steeply rising inflation. Some studies highlight that despite understanding the importance of financial planning, most people do not take any streamlined action. If you are earning, spending, saving, and investing your money without much thought or a full-course plan, you are making a financial planning mistake. Similarly, another common personal financial planning mistake is to not have descriptive goals with only a vague idea of your financial resources. For instance, you can save your funds in a savings account or invest the money in a tax-advantaged retirement account. With proper structuring of goals, you might be tempted to save the money in your savings account to ensure liquidity. However, saving in a tax-advantaged account like an IRA (Individual Retirement Account) has long-term advantages, such as retirement security, tax benefits, and more. Without a comprehensive financial plan and accompanying tools like a budget, it can be daunting for you to contemplate monetary decisions like where you are headed, where you want to go, and how you want to get there. Hence, it is best to avoid this financial mistake and start planning as soon as possible.
Successful financial plans are subject to an in-depth understanding of your financial situation and a clear vision of your financial goals. The objective is to create a sound financial plan that can aid your life goals and not set unrealistic expectations regarding the future. Moreover, financial plans that do not account for future exigencies have high chances of failing in the long term. Hence, it is advised to create a financial plan with realistic expectations and assumptions. For instance, you assumed you would retire with $1 million in your 401(k) accounts and IRA. You planned to work till the age of 70 to maximize your Social Security benefits. However, owing to health issues, you had to take an early retirement around your 63rd birthday. If you could continue working until 70, you would have been close to your million-dollar goal. But since you took early retirement, your savings balance is only $650,000, which is significantly insufficient to cover your retirement living expenses for your remaining years of life. Hence, you downgraded to a smaller home, relocated to a tax-friendly state, took up a part-time job, etc., to fund your living expenses. However, this can happen because of a money management mistake, such as not accounting for a possible health crisis leading to loss or shrinking income. An ideal financial plan must account for a potential health crisis, income loss, early retirement, longer life expectancy, changes to Social Security norms, etc. The objective is to create a financial plan that sets realistic and traceable goals like accommodating a retirement nest egg, creating an emergency corpus inclusive of six months of living expenses, etc.
It is not uncommon for you to think that bad things will not happen to you. Many people believe that they will not face an emergency. However, life is unexpected, and you cannot time an emergency. The best way to handle a contingency is to be financially prepared for it. Financial experts recommend having at least six months of your living expenses as an emergency reserve. However, given the state of unemployment and the rising cost of living, it is advisable to create an emergency fund with nine months of living expenses. Despite acknowledging the importance of having an emergency fund, most people tend to make the financial mistake of not creating one. A 2021 survey pointed out that nearly one in every four Americans have no emergency savings. Those with an emergency fund have only three months of their living expenses as a reserve. If you are also making this financial mistake, it can prove detrimental to your long-term financial goals. Further, after the COVID-19 pandemic, the importance of an emergency fund has increased manifolds. The abrupt changes brought by the pandemic jolted the basic financial system of life, causing job losses, reduction in income, health issues, and more. The COVID-19 pandemic was harsher for those who entered the pandemic without a strong financial footing. Hence, it is advisable to have an emergency fund to handle unexpected financial emergencies.
An effective budget is the foundation of a healthy financial plan. By creating a financial budget, you can adequately cater to your present and future needs. However, it is critical to create a workable budget and not a restrictive one. A workable budget will assess your current expenses, earnings, debt, priorities, short-term and long-term financial goals, etc., and create a healthy balance of all aspects. The objective is to document your spending patterns and itemize regular expenses to get a hold of your expenses and precisely understand the outflow and inflow of your funds. Once you know your financial situation, you can create a budget where every dollar is spent wisely. Living life on a workable budget will enable you to cut down on your unnecessary expenses and deploy surplus money towards your financial targets. Using a budget, you can identify areas where you are overspending and trim down your discretionary expenditures, such as online subscriptions, dining out, etc., to ensure optimum money utilization.
It is easy to put off saving, especially when you are young or tight on your budget. However, this is a financial planning mistake that you must avoid. Not saving enough or having insufficient savings can cause you to miss out on the power of compounding. Saving now rather than later will ensure your funds start working for you earlier. Saving early, irrespective of your earning level, will help you achieve your financial goals easily and quickly. You can automate your savings to ensure you pay yourself first and not overspend. However, it is important to select the right medium to save your money. You can use tax-advantaged retirement accounts like an IRA or a 401(k) account to save and invest your money. These accounts allow you to contribute pre-tax dollars while offering tax-free growth until withdrawn. Ignoring these tax benefits is a common personal financial planning mistake that most people make. It may help to maximize your contribution to these accounts to reach your goals sooner. For 2022, you can contribute up to $20,500 in your 401(k) account and $6,500 more if you are 50 years or older. In an IRA, you can save up to $6,000 annually, and if you are 50 years or older, you can save up to $7,000 in 2022. Maximizing your contributions will help you get the most tax benefits. Among other things, focus on maximizing your 401(k) contributions to get equal contributions from your employer, typically free money.
A common financial planning mistake that most people make is overspending. Merely creating a budget is not sufficient. The objective is to follow the budget and cut down on excessive spending. However, most of the time, when you have surplus funds, you are tempted to buy something rather than pay down debt or increase your savings. This is known as ‘Lifestyle Creep’. As a wise financial planner, you should strive to live within your means and not make spending mistakes in personal finance to keep up with your peers. Hence, when you receive a hike in salary or get more business profits, it is best to continue to live as if the increase never happened. The motto is to use the additional money to prioritize your financial goals, such as paying off debt, saving more for retirement, creating an emergency corpus, etc. You should celebrate your achievements, but make a financial plan to prioritize your goals.
Among other common personal financial planning mistakes, one that you should be wary of is making unwise investments. A sound investment portfolio is critical for your future growth and security. Your portfolio should ideally align with your financial goals and risk tolerance to maximize your gains and support wealth accumulation in the long run. Focus on selecting the right investment options per your life stage, risk tolerance, and financial objectives. For instance, if you are a conservative investor with a low-risk appetite, you can create a portfolio with fixed-income investments, such as debt securities, balanced with some equity investments. Alternatively, if you are a high-risk investor, you can consider investing significantly in stocks and balance your portfolio with some debt-related securities, alternative assets, etc. The ultimate plan is to create an investment portfolio aligned with your risk appetite and financial objectives. Once you create a well-diversified investment portfolio, avoid making the financial mistake of not reviewing and rebalancing your portfolio over time.
Taxes consume a large part of your hard-earned money. According to a study, an average American approximately pays $10,500 as income tax annually, 14% of the average American household budget. Hence, it is wise to use smart strategies to minimize your tax liability. But most people make the financial mistake of not using effective tactics to optimize taxes. You can use tax-advantaged retirement savings accounts, like an IRA, 401(k), etc., and contribute up to their maximum limit to save on taxes and also effectively work towards saving a retirement corpus. Alternatively, you can also use a Roth IRA, back-door IRA, etc., to create a tax-free savings corpus. Further, Health Savings Accounts (HSAs), and tax-friendly investments like municipal bonds, index funds, qualified dividends, etc., can lower your tax bill. Tax-loss harvesting and capital gain offsetting strategies further reduce your tax burden. For instance, if your taxable turnover is less than $7,875 (long-term gains) and $39,375 (short-term gains), you can ask your financial advisor to create strategies for a 0% capital gain tax rate.
A money management mistake you might make is forgetting to check up on your insurance plans. Before renewing your insurance policy, check if your current insurance plans (inclusive, car, home, business, life, etc.) are adequate for your present life stage and needs. Also, assess if you are getting any better insurance rates from elsewhere. In terms of life insurance, check if the sum assured is sufficient to cover the growing needs of your family. Further, reassess the beneficiaries of your life insurance plans. If you quit smoking, inform your insurance provider and appraise your life insurance policy accordingly to get better discounts on insurance policy renewal. Moreover, in terms of home insurance, evaluate if your insurance policy reflects the new and updated value of your house. If you are nearing retirement, it is advised to not make the financial mistake of forgetting to buy a long-term care policy that can support you in case of mental or physical incapacitation.
Another financial planning mistake to avoid one should avoid making is not prioritizing estate planning. Irrespective of how large or small your asset balance is, estate planning is essential for everyone. With the right estate plan, you can effectively cater to your needs when alive (especially in situations like mental and physical incapacitation) and even leave a tax-optimized legacy for your family and children. Estate planning involves taking stock of assets, getting an asset valuation, drafting a will, assigning estate shares to the nominees, reviewing beneficiary designations, streamlining foreign investments, reducing estate taxes, setting up trusts, and so on. Your estate plan allows you to list down directives for the usage of your assets even when you are alive. Further, these directives can help govern the distribution of your assets. A foolproof estate plan enables you to pass on assets to your beneficiaries in the most tax-efficient manner. If you have minor children, your estate plan can help you set up guardianship for your children. You can also set up a living trust, appoint trustees, medical directives, and more. An estate plan enables you to govern how your assets are passed, dispersed, and used by the recipients after your demise.
To conclude
By being careful of these financial mistakes, you can live a financially disciplined life and create a strong foundation for a secure future. Despite understanding these aspects, it is possible for you to make some unavoidable financial mistakes, such as emotion-based investing, forgetting to use tax-advantaged accounts, etc. Hence, it is beneficial to consult a professional financial advisor to help you create an infallible financial plan for a sheltered future.
To get in touch with a fiduciary advisor who may help create a financial plan for you and advise you on which critical financial planning mistakes that you should avoid making, use the free advisor match service. Based on your requirements, the platform scans through registered and qualified advisors to match you with an advisor suited to your needs and goals.